Consolidative Tone Overshadows Economic Data

There is still a holiday hang-over in the markets, where many seem reluctant to make new commitments ahead of the key developments in the coming days. These include ECB's Draghi's press conference and the US jobs data. Economic data including surprisingly strong German retail sales (Nov +1.5% month-over-month) and a smaller than expected Australian trade deficit (-A$118 mln vs. -A$300 mln consensus) failed to lift the euro or Australian dollar.

The price action in the Australian dollar is particularly noteworthy. It peaked last Friday just above $0.9000 and managed to stay above the 20-day moving average yesterday. Recall that this moving average had turned back Aussie rallies four times in the Nov-Dec period. With the continued slippage in Europe, after the Asian decline, the Aussie is now slipping back below the 20-day moving average, which comes in near $0.8922 today.

As noted the trade deficit was reduced, but not for reasons that point to a better economic outlook. Exports were flat and imports fell 1%. Some observers are attributing the Australian dollar's decline to the softer China PMI readings.

An important piece of data, before the ECB's meeting on Thursday, is the preliminary December inflation report. The 0.8% increase on year-over-year basis was in with expectations. In November, it stood at 0.9%. The core rate, which is seen as less important from a policy making point of view than in the US, slipped to 0.7% from 0.9%. In recent statements, Draghi has not appeared to project a sense of urgency to provide more monetary accommodation, despite the draining of excess liquidity by the repayment of LTRO borrowing, the weak money supply growth or the continued contraction in bank lending.

The euro is consolidating at the upper end of yesterday's range. Immediate resistance is seen in the $1.3655-75 area. The euro's resilience is striking. We note that EONIA which peaked at the end of the year near 45 bp is now below 10. The US-German 2-year spread was just below 7 bp in mid-December and 17 bp today. Separately, we note that the bund is trading above its 200-day moving average against the Swiss franc. It finished the North American session above there yesterday and has motored higher today. The 200-day average is seen near CHF1.2315 today.

There has been strong demand for Ireland's new 10-year bond and this has helped renewed demand for other Italian and Spanish paper too. Spain is clearly the favorite of the two now. It has yet to show up convincingly in the equity market, however.

Japan's 10-year bond auction was also well received. The bid-to-cover was 3.84, down slightly from the previous auction, but still healthy. The difference between the lowest and average price -- the tail -- was unchanged at 0.01. Japan's 10-year benchmark yield rose to 3-month highs in late December, but with today's 3.4 bp decline, it is being corrected.

The Nikkei fell 0.6%, even though the yen did not build on the gains seen in North America yesterday. Financial and oil and gas were the hardest hit in the Nikkei, while insurers and transport services sectors were the weakest in the Topix. Yesterday, the dollar slipped through its 20-day moving average against the yen for the first time in two months, though finished just above it. That average comes in today around JPY104.20.

Janet Yellen was confirmed by a 56-26 vote in the Senate as the next Chair of the Federal Reserve. In 2010, when Bernanke was re-nominated, 30 Senators voted against him. Yellen is also the first nominee by a Democrat President that was not simply the reappointment of the sitting Chairman since Volcker in 1979. Yellen is seen guiding the Fed on the path that Bernanke outlined.

That means that barring a downside shock to the jobs report, the Fed will announce tapering of another $10 bln at the FOMC meeting later this month. The Fed has consistently argued that the easing of QE lies with the size of its balance sheet, the stock of its purchases, not with the purchases themselves, or flow, which is what market participants typically emphasize. While the incremental addition may slow, the stock of is expected to be increasing for the bulk of the year.

The only US data to note today is the Nov trade balance. It will allow economists to fine tune Q4 GDP forecasts as it will be the last trade report until the first look at Q4 US GDP on Jan 30. Regional Presidents Rosengren (dissented from the tapering decision) and Williams speak today.

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